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The finance industry is slow in its willingness to innovate around technology, and is behind other industries says Jessica Donohue executive vice president, chief innovation officer and head of advisory and information solutions at State Street.

And the cost of that inability, or stubbornness, around technology innovation is not inconsequential.

State Street recently released its 2014 Data and Analytics Survey which analyses data analytics as a strategic priority for 400 investment organisations, including asset owners and asset managers.

The result is a clear divide in the industry between data starters, data movers, and data innovators.

The data innovators are treating data as their top strategic priority and are mastering a range of advanced data capabilities. They have the edge on electronic trading, extract commercial insight from their data and can adapt faster to business needs, the survey finds.

“Mastering data is both a huge challenge and opportunity for today’s investment organisations. Companies in the survey with the most advanced data practices believe they already have a significant competitive advantage. They can analyse risk and performance across today’s complex multi-asset portfolios. They have systems that streamline compliance and allow them to adapt to new stakeholder demands. And they have the flexible infrastructures and data skills to keep pace in a fast-changing environment,” the report says.

An important point between starters and innovators, Donohue says, is there is not a firm which doesn’t acknowledge it’s important, but the differences come from a firm’s ability to invest or elevate it to the number one strategic priority.

Donohue says the data innovators tend to be funds managers, not asset owners.

“This is no surprising because asset owners are more complex and have many sources of data. They also have tended to outsource decisions and data to managers,” she says. “Asset owners have also not had a commercial imperative to manage their data. But as they are trending towards self-managing their assets they are being pushed into solving their data problems.”

State Street believes that advanced data tools and practices will be one of the most powerful agents of change in the investment industry over the next 10 years, and Donohue also says it is a natural extension of State Street’s business to bring data to the front office, and plays to its strength in its back and middle office services.

Asset owners are starting to look seriously at the technology tools for a total portfolio view of their assets, partly because regulators are creating the imperative. But performance will, over time, be a driver as well.

“It’s hard to get a portfolio view, and a lot of asset owners haven’t required that from providers. But that’s just historical risk, even the most sophisticated investors and fund managers can’t do forward looking risk. There are a number of CIOs sitting without a full portfolio view of their risk. This should make us all sit up straight,” Donohue says.

State Street is taking technology innovation seriously, evidenced by the chief technology officer of the State Street GX Lab being located in Silicon Valley.

The GX Investment Labs convert State Street’s most widely followed research ideas into practical and interactive tools and include a Risk Lab, a Liquidity Lab and a Portfolio Lab.

Donohue says the over-arching aim is to create a platform that clients can use at any point in time and have a complete view of the entire portfolio and test ideas in real time.

“Imagine more willingness to trade because you know why you are trading and the risks involved. There is paralysis now because people don’t understand the risks so they stand still. Increased activity without productivity is not good, but more liquidity in the market would be great,” she says.

State Street has been using gaming technology to build the tools which will be open architecture and built in modules to accommodate technology upgrades.

“A big issue for the industry is it is full of black boxes instead of transparency. Quant models, pricing models, vendor data, they’re all black boxes. If you want historical prices you have to pay for it. It’s not free, I really don’t get that,” she says.

The system will allow investors to “preserve scenarios” so there is a record of back-testing which is good data governance.

“Governance and security of data will preoccupy people’s minds more,” Donohue says, “which is also an imperative to invest in technology. If you don’t know where or what the data is, then you don’t know it’s secure.”

Transparency is at the forefront of data analytics, she says, particularly given as a fiduciary, clarity is important.

“The healthcare industry has really embraced data and analytics and really moved the dial in a substantial way. Car companies now use chips in cars that are gathering huge amounts of data from things like movements in the steering wheel. They are collecting data to understand behaviour. The finance industry has real legacy system issues, but so did those other industries. We haven’t made it a priority,” she says.

Donohue believes the tools and innovation in finance will change with a generational change.

“They are used to visualisation and gaming technology and then they’ll walk into finance and expect to be able to use those tools. We are focusing a lot on dash boarding and visualisation. The next generation learns through graphics not spreadsheets.”

The survey asked the industry data questions around infrastructure, insight, adaptability, compliance, talent and governance. State Street aims to benchmark the industry with regard to data capabilities in these areas. It is also creating an APP so clients can benchmark their activities against the survey results.

Investors say they like to, and want to, focus on the long term, but they often don’t know how to change their practices to orient their governance and investments to do so. Now, finally, a guide has been developed for investors to use as benchmark for implementing strategies for long-term investment.

The guide is an output of the Focusing Capital on the Long Term initiative, which has input from 20 investment professionals from managers and asset owners including CPPIB, OTPP, PGGM, New Zealand Super and Washington State Investment Board, all of which contributed to the guide with case studies of long-term “ideas in action”.

For any asset owner wishing to put in place an effective set of implementation strategies and tools to help realise their aspiration to be long term, this is a must read.

The guide focuses on areas where asset owners and managers have the ability to act immediately, and outlines examples of that in practice through case studies of institutional investors.

The areas of focus in the guide are investment beliefs, risk appetite, benchmarking process, evaluations and incentives, and investment mandates.

The Long-Term Portfolio Guide is an output of the Focusing Capital on the Long Term (FCLT) initiative. Its development was led by Anuradha Gurung with co-editor Colin Carlton and a working group, co-led by Caisse de dépôt et placement du Québec and Canada Pension Plan Investment Board. The working group was comprised of more than 20 experienced investment professionals from BlackRock, Caisse de dépôt et placement du Québec, Canada Pension Plan Investment Board, Capital Group, GIC, New Zealand Superannuation Fund, Ontario Teachers’ Pension Plan, PGGM, and Washington State Investment Board.

To read the paper click below or go to www.fclt.org

FCLT_Long-Term Portfolio Guide

Efficient markets theory has been challenged by the finding that relatively simple investment strategies are found to generate statistically significantly higher returns than the market portfolio. Well-known examples are the value, size and momentum strategies, for which return premiums have been documented in US and international stock markets. Market efficiency is also challenged, however, if some simple investment strategy generates a return similar to that of the market, but at a systematically lower level of risk. Read the full article.

A research paper that concludes that the funds recommended to institutional investors by investment consultant do not add value, has won the Commonfund Prize, awarded for original research relevant to endowment and foundation asset management. The paper, by academics at Saïd Business School, Oxford University and University of Connecticut School of Business, found that there is “no evidence that these recommendations add value, suggesting that the search for winners, encouraged and guided by investment consultants, is fruitless.”

The winning paper, Picking winners? Investment Consultants’ Recommendations of Fund Managers, by Tim Jenkinson, Howard Jones, (Saïd Business School, Oxford University) and Jose Martinez (University of Connecticut School of Business) analyses the factors that drive consultants’ recommendations of US actively managed equity funds, and the impact these recommendations have on flows, as well as how well the recommended funds perform.

The authors find that investment consultants’ recommendations of funds are driven largely by soft factors, rather than the funds’ past performance, and that their recommendations have a very significant effect on fund flows. But there is no evidence that these recommendations add value.

The Commonfund Prize is awarded annually by the Commonfund Institute in collaboration with the Newton Centre for Endowment Asset Management at Cambridge Judge Business School. The winning paper carries a $10,000 prize.

Endowment and foundation funds are most commonly seen in the charity, education and healthcare sectors. Although regular withdrawals from the invested capital are needed to meet on-going operational costs, such funds are typically characterised by a perpetual time horizon.

First awarded in 1996, the Commonfund Prize aims to recognise original research and to set the standard for research excellence and innovation in this area of asset management.

There were two papers chosen as runners-up in the category of highly commended:

Laura Starks (University of Texas at Austin) and Richard Sias and Luke DeVault (University of Arizona) for Who are the Sentiment Traders. Evidence from the Cross-Section of Stock Returns and Demand

Neal Stoughton, Georg Cejnek, and Richard Franz (Vienna University of Economics and Business) for An Integrated Model of University Endowments

The judging panel consists of David Chambers, the Academic Director of the Newton Centre for Endowment Asset Management and Reader at Cambridge Judge Business School; Elroy Dimson, the Centre’s Chairman and Professor of Finance at Cambridge Judge Business School; and William Goetzmann, Professor of Finance and Director of the International Center for Finance at the Yale School of Management.

What would Keynes’ do? Delegates at a London investment think-tank discussed this question with Cambridge University’s David Chambers. Keynes started managing the Kings College, Cambridge endowment after World War I and analysis of his investing style reveals some interesting annotations for investors today.

John Maynard Keynes was not just an economist – he was a fund manager and stock picker. Analysing the way he managed investments, his style, tilts, returns and strategies supports analysis that long-horizon investors have advantages.
Keynes was appointed the bursar of King’s College just after World War I and managed its endowment, which at that time was largely made up of a substantial agricultural property portfolio dating back to the 15th century. Throughout his career, he was an active and innovative investor and his first act to buck tradition, or think outside the square, was to reallocate the portfolio away from property and fixed income securities towards equities. His willingness to make a substantial allocation to this new asset class in the 1920s was unique amongst institutional investors on both sides of the Atlantic and anticipated the widespread move into equities by institutions a generation later.
David Chambers, University Reader and Keynes Fellow at the Judge Business School at Cambridge University, told delegates at a recent London investment think-tank that one of the lessons from analysing Keynes’ portfolio management skill is that as an active investor it is better “not to be restricted by convention and to seek where possible well-considered risks in order to perform”.
In 1921 Keynes’ carved out a discretionary fund within the Kings College endowment which he invested in equities up to his death in 1946.
This UK discretionary fund generated a mean annual return of 16.0 per cent with a standard deviation of 19.1 per cent over these 25 years compared to a 10.4 per cent return and 17.1% volatility for the UK equity market.
“His portfolio had a very high tracking error, an obvious tilt towards value and a tilt towards small and mid cap stocks,” Chambers says.
Following a period of disappointing performance relative to the index in the period between 1926 and 1928, Keynes began a thorough overhaul of his investment approach in the early 1930s and subsequently outperformed the market by a substantial margin.
“Keynes spent the 1920s trading as a macro trader would today trying to time markets. Unfortunately, he didn’t anticipate the 1929 crash at all and was 90 per cent invested in equities.
“He approached currency trading in a similar way, attempting to time currency moves based on his careful analysis of fundamentals such as trade, inflation, interest rates and politics.”
Yet, his currency returns were extremely volatile as a result of his difficulty predicting the timing of currency movements, and although overall he made money, at times he was forced to endure substantial losses. Hence, Keynes wrote in December 1934 about the prospective French franc and Dutch florin devaluation that “Nothing is more rash than a forecast with regard to dates on this matter. The event when it comes will come suddenly. The best thing is to allow for probability and put little trust in forecasts of the date, whether soon or late”.
Importantly, however, when it came to equity investing, Keynes was able to change his investment approach. He abandoned the idea of a top-down market-timing approach in the 1930s in favour of a bottom up stockpicking approach.
This is evidenced by the decline of stock turnover in the portfolio turnover from 55 per cent in the 1920s, to 30 per cent turnover in the 1930s to 14 per cent turnover in the 1940s, Chambers says.
His switch to a patient buy-and-hold strategy allowed Keynes to stay committed to equities, and reflects his realisation of the natural advantages that accrue to such long horizon investorsas endowments Chambers says.
“Keynes’ investment experiences during the Great Depression of the 1930s are relevant to modern-day investors during the Great Recession. He had to discover for himself the difficulty of making profits from market timing when the stock market crashed in 1929. Thereafter, his self-proclaimed switch to a more careful buy-and-hold stock-picking approach in the early 1930s allowed him to maintain his commitment to equities when the market fell sharply once more in 1937-38. In so doing, he provides an excellent example of the opportunity which long-horizon investors have in being able to behave in a contrarian manner during economic and financial market downturns,” Chambers and his co-authors, Elroy Dimson and Justin Foo outline in the paper “Keynes, King’s and endowment asset management”.
“Studying Keynes’ investment record also demonstrates another important lesson for investors today, namely, that it can take a while to discover the nature of your investment skills,” Chambers, who is academic director of the Newton Centre for Endowment Asset Management at Cambridge, told delegates at the think-tank.
When reflecting on the importance of learning from history, Chambers spoke to delegates about the link between the investment approach pursued by the leading US endowments today and that of Keynes almost a century earlier and discussed in a new paper “The British Origins of the US Endowment Model” co-authored with Elroy Dimson. Quotes from “Pioneering Portfolio management” by Yale endowment CIO, David Swensen, could have been taken from Keynes himself:
“…active management strategies demand uninstitutional behaviour from institutions…
“Establishing and maintaining an unconventional investment profile requires acceptance of uncomfortably idiosyncratic portfolios, which frequently appear downright imprudent.
“Unless institutions maintain contrarian positions through difficult times, the resulting damage imposes severe financial and reputational costs on the institution.”
In the end, Chambers says lessons from Keynes demonstrate that for an active investor it is important not to be restricted by convention. It is also very important for a manager to be situated within a governance structure, or investment organisation, which, following prior discussion and agreement about the preferred investment strategy, allows them to take adequate risk and to go about applying their skills.

Chambers, Dimson and Foo “Keynes, King’s and endowment asset management” NBER working paper:http://ssrn.com/abstract=2499334
Chambers and Dimson “The British Origins of the US Endowment Model” Financial Analysts Journal http://ssrn.com/abstract=2541034

John Maynard Keynes
1902-05 undergraduate at Kings College
1906 India office
1909 Fellow, Kings College
WWI UK Treasury
1919 First book: Economic Consequences of the Peace
1923 Tract on Monetary Reform
1925 Economic Consequences of Mr Churchill
1930 Treatise on Money
1936 General Theory
1940 UK Treasury
1941 Bank of England
1944 Bretton Woods

Hedge funds are sheep in wolves’ clothing, they are claiming their returns to be alpha, but a large part of it is driven by beta, Narayan Naik, professor of finance, London Business School told delegates at an investment think-tank in London last week.
The good news, Naik says, is a new era has dawned in hedge fund investing where investable risk factors enable investors to identify genuine alpha producers and direct capital towards those managers and products, and the rest directed to risk-factor funds.
“This enables investor to use risk factors for portfolio completion, diversification, and tail-risk hedging purposes, “park” excess cash in a diversified basket of risk-factors until they find the right manager, and most importantly allows them to pay alpha-price for alpha-like returns and beta-price for beta-driven returns,” he says.
Naik told delegates that hedge fund returns look like an iceberg, there’s a little bit of alpha showing above the water and all the beta is under the water.
The returns, he says, are made up of alpha which is the return due to manager skill, and the remaining return drivers – the alternative beta, exotic beta and traditional betas – are the returns due to systematic risk factors.
The evolution of hedge fund offerings has seen alternative beta returns now captured using risk factors whereby the beta is constructed using liquid tradeable securities and their derivatives.
“Combining known risk factors such as rates curve, currency carry, equity liquidity, commodities momentum and value, emerging markets has meant that products can now capture a large part of hedge fund returns,” he says.
In 2007, the first hedge fund strategy clone was launched that delivered alternative beta-based returns but did not carry the high cost of the underlying active management (hedge fund fees).
“These clones are rules-based, cheap, highly transparent, with high degree of liquidity, institutional quality and free of headline risk,” he says.
“Of course sceptics say, can an auto pilot fly a plane better than a pilot? But if you look at hedge fund returns from June 2007 to February 2013 you can see that risk factors explain a lot of what the average hedge fund is doing, alternative risk factors capture a lot of their investment returns,” he says.
The next generation of funds have now arrived, Naik says, where the building blocks, or decomposed risk factors, can be used by investors to build their own basket of risk factors to suit their needs.
“A new era has dawned where investable risk factors enable you to identify genuine alpha producers. Most importantly it allows you to pay alpha-price for alpha-like returns and beta-price for beta-driven returns,” he says.
“Alpha is different for different people it is a nebulous concept. But I define it as what I can’t do or access in a cheap and transparent way. It is partly perception, partly what you can do versus what you can’t do.”
In answering the question if there is enough alpha around for investors to share, he says it is important to go back to expectations.
“What am I expecting from hedge funds, what should a manager earn after transaction costs before I pay 2:20?. You have to go back to expectations of what you want from hedge funds, what am I expecting from these investments and how does it complement the rest of the portfolio?
In looking at return and risk expectations Naik reminded delegates that between 2002 and 2010 the MSCI World worst 21 months produced -6.8 per cent, and the best 21 months produced 6.94 per cent.
The returns for the mega firms in the hedge fund world, those that hold 90 per cent of the hedge fund assets, for the worst 21 months were -0.4 per cent and the best 21 months were 1.6 per cent.
Naik cautioned investors there was agency problem in the concentration of assets in the hands of a few hedge fund managers. The capital distribution of the industry is such that the big funds seem to be getting bigger. The good old 80:20 rule appears to be more like 90:10 for the hedge fund industry, with 90 per cent of the assets are being managed by 10 per cent of the names.
“It’s the age-old saying you can’t be fired for buying IBM, the same thing applies to hedge funds today, you can’t be disciplined for buying the big funds like Highbridge, Bridgewater, Brevan Howard, Winton and so on. These choices seem to be driven, in part, by career concerns on the part of institutional investors – a common agency problem we face in delegated portfolio management.”